THE TAYLOR PRINCIPLE AND (IN-) DETERMINACY WITH HIRING FRICTIONS AND SKILL LOSS

Ansgar Rannenberg

Macroeconomic Dynamics, 2015, vol. 19, issue 5, 1045-1073

Abstract: We introduce skill decay during unemployment into a New Keynesian model with hiring frictions and real-wage rigidity. Plausible values of quarterly skill decay and real-wage rigidity turn the long-run marginal cost–unemployment relationship positive in a “European” labor market with little hiring but not in a fluid “American” one. If the marginal cost–unemployment relationship is positive, determinacy requires a passive response to inflation in the central bank's interest feedback rule if the rule features only inflation. Targeting steady-state output or unemployment helps to restore determinacy.

Date: 2015
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